Sunday, 28 February 2016

The
dismal performance of exports, not excessive spending on imports, is behind Egypt’s
currency woes.

Correct diagnosis
is key to successful treatment. On 21 February, the governor of the Central Bank
of Egypt, Tarek Amer, gave
a TV interview outlining his diagnosis to the country’s ongoing struggle with
a currency crisis, which has led to intense speculations about a possible
devaluation of the Egyptian pound. Below are a few remarks on the interview.

1. What is the central bank’s diagnosis of the
problem? The
governor was clear in his assessment: the excessive increase in imports
over the last few years is to blame for the crisis. This has led to a large
demand for the US dollar, which reduced its availability and led to pressures
on the Egyptian pound.

2. Is the central
bank correct in its diagnosis? No. It is natural for spending on imports to
increase with the rise in income. It would only be considered excessive if its growth
far exceeded that of national income, which has not been the case in Egypt. Imports
grew at an annual rate of 4.7% between 2010 and 2014, lagging the 7.0% annual growth
in Egypt’s nominal gross domestic product (GDP), a measure of income for the
country. There is nothing excessive about this. In fact, the share of imports in
GDP fell from 31% in 2010 to 28% in 2014.

3. If imports are not the
root cause of Egypt’s currency crisis, what is? The answer is exports. In 2010,
Egypt’s exports were valued at $49bn. In 2014, this number fell to $47bn. As a share
of GDP, exports fell from 23% in 2010 to 17% in 2014. The fall in exports meant
that Egypt earned fewer US dollars than it did in the past, which led to a
shortage of foreign currency.

4. What explains
the decline in exports? The main reason is that Egypt lost market share in its
export destinations, despite the overall growth of exports to these markets. For
example, Egyptian exports accounted for 1.5% of total exports to Saudi Arabia in
2010. But this share fell to 1.2% in 2014. Among the largest 43 trade partners
of Egypt, the share of its exports declined in 31 countries between 2010 and
2014.

5. What could
explain the dismal performance of Egyptian exports over the last few years? Potential
explanations include: First, Egyptian exports may have become less appealing
because they have become more expensive, either because inflation has pushed up domestic costs or because the Egyptian currency has
appreciated against competitors’ currencies. Second, demand for Egyptian
exports could have declined due to either security concerns (affecting
tourism), the slowdown in global trade (impacting traffic in the Suez Canal) or
the quality of Egyptian exports. Third, the capacity of Egypt to produce exports
may have been constrained due to power cuts in factories, the shortage of foreign
currency required to buy intermediate goods for production or the destruction of
the gas pipeline in Sinai, which reduced exports to Jordan.

Sunday, 21 February 2016

The agreement to freeze oil production will do little to rebalance the market.

Russia, Saudi Arabia,
Qatar and Venezuela agreed on 16 February to freeze
oil production at January levels, if other countries join in. Despite the
publicity, the move does not change the dynamics of the oil market in any significant
way. Its impact is likely to be limited for three reasons:

1. The quartet
alone have limited potential to increase production anyway. Annual oil production
in Qatar and Venezuela is expected to decline in 2016, according to forecasts
from Goldman Sachs. And while output in Russia and Saudi Arabia is expected to
rise this year, some of this might have already been realised in January. Total
production from the quartet is expected to increase by only 270 thousand
barrels per day (k b/d), not enough to rebalance the market in a meaningful
way.

2. The main growth
countries (Iran and Iraq) are unlikely to join the freeze. Iran can convincingly
argue that it needs to make up for the lost production during the years of
economic sanctions. It currently produces around 0.7m b/d below its 2012 peak.
Meanwhile, Iraq is struggling with revenue shortages and a large budget deficit
and is unlikely to commit to any cap to its oil production. Indeed, the
statement issued after oil ministers from the two countries met with their
Qatari and Venezuelan counterparts was polite
but lacked any enthusiasm to join the deal.

3. The output freeze
is unlikely to be a precursor to a future production cut agreement. OPEC’s strategy
to increase production, defend market share and squeeze US shale oil firms out
of the market is finally bearing fruit. US oil production is expected to
decline by 492k b/d this year as US oil firms are unable to recover their costs
under current oil prices. A production cut from OPEC could give these firms a
lifeline to come back into the market and fill the gap vacated by OPEC.

In addition, OPEC
will probably face internal disagreements on how to allocate any production cut
among member countries. Even if these disagreements were resolved, temptations would
be high for individual countries to deviate and produce more.

So despite initial
market enthusiasm, the production freeze agreement is unlikely to be a game
changer.

What is McKinsey saying?
It says that Saudi Arabia can increase the income of its citizens by developing
its non-oil sectors. Some of the discussion on the potential of certain sectors
to grow is insightful, as in the case of the automotive industry. McKinsey
argues that Saudi Arabia has the ingredients to develop this industry given the
size of its domestic market, the growth in neighbouring countries and the lack
of manufacturing hubs in the region. But in other cases, the imagined potential
is unrealistic. For example, McKinsey claims that Saudi Arabia can increase the
number of religious tourists five-fold to 50m by 2030 by sustaining all year round
the number of pilgrims seen during the Hajj season. And I want to have Christmas
every day, please.

That said, the overall
case for the potential of the economy to grow is convincing. The question then
is how to do it. Economies grow by either increasing the number of people working,
or by making working people more productive. McKinsey suggests that the former
can be achieved by encouraging more Saudis to participate in the labour market.
The participation of women, in particular, is very low. Only 18% of working-age
Saudi women participate in the workforce compared with 51% in Indonesia, 44% in
Malaysia and 29% in Turkey. McKinsey also suggests that productivity can be
boosted by allowing more competition (which would push firms to perform better
in order to survive), reducing restrictions on foreign labour to move between
jobs, and increasing the productivity of workers through education and training.

But this is where
the report falls short. It is all good recommending increased competition in
the product market or more flexibility for foreign workers, but the current state
of affairs is in place because there are vested interests benefiting from it. Likewise,
it is easy to recommend boosting productivity through education and training
but Saudi Arabia already spends a quarter of its budget on education with meagre
results. Saudi students underperform their international peers in standardised tests,
and the university dropout rate is close to 50%.

I would have expected
more practical recommendations from a firm like McKinsey given its global reach,
its work across different sectors and its “micro-to-macro” approach to
economics. I would have expected them to provide insights and lessons from
success and failure stories where countries tried to overcome vested interests,
increase competition or boost productivity through education and training. The insights on how to achieve these objective are unfortunately lacking in the report.

So overall, the
report makes all the sensible high-level recommendations but falls short when
it comes to practical implementation.

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About Me (Ziad Daoud)

I am an economist currently based in the Middle East. I have previously worked for an asset management firm and, before that, I did a PhD at the London School of Economics. The views in this blog are solely my own.